Headlines this week proclaimed that America’s GDP had shrunk for the first time in more than eight years. They focused on real GDP, adjusted for inflation, which fell at an annual rate of 0.4% in the third quarter, a smaller drop than had been expected. Real GDP is widely forecast to fall again in the fourth quarter, meeting the popular definition of a recession, The Economist is reporting this morning. Less noticed, but perhaps more worrying, is the slump over the past year in America’s nominal GDP growth, the dollar value of economic activity.

In plain, not-adjusted-for-inflation, money terms, GDP growth tumbled to only 1.8% in the third quarter, from 8% in the second quarter of 2000. As both output and inflation decline, nominal GDP growth will slide further; it could even go negative. On current trends, 2001 and 2002 are likely to experience the slowest growth in nominal GDP in any two consecutive years since the 1930s.

The reason why nominal GDP growth is so sluggish is that America entered this recession with inflation at a historically low level. The start of every previous downturn in the past four decades has been marked by rising inflation. This prompted central banks to lift interest rates, leading to a recession, even as inflation remained high for a while.

America’s current recession, however, has been caused largely by an investment boom that has turned to bust. Increased competition and ample global capacityÑalong with (arguably) sound monetary policyÑhave held down prices. Inflation is likely to fall further over the next few years as global excess capacity weighs on prices. According to the University of Michigan’s latest consumer survey, inflationary expectations have fallen to their lowest for more than 40 years.

Inflation is declining everywhere; and nominal GDP is also falling in several economies around the world. The most dismal case is Japan, where deflation has helped nominal GDP to fall continuously since 1997. The Bank of Japan forecast this week that it will continue to decline into 2003. Nominal GDP is also shrinking in Singapore, Hong Kong, Taiwan, Malaysia and Argentina. For the world as a whole nominal GDP growth has fallen to around zero, its lowest since the 1930s.